Gold is starting 2014 on a high note, rising 4 percent after finishing off the worst year since 1981. And with bullion now trading at two-month highs, traders say a short squeeze could be imminent.

"In a heavily shorted market, you'll get to a level where people can no longer stand the pain, and then everybody rushes to the exit at once, causing the move to feed off of itself," said Jim Iuorio of TJM Institutional Services.

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According to the Jan. 14 Commitments of Traders report from the Commodity Futures Trading Commission, short bets on gold rose by 2.9 during the previous seven days, adding to the already-sizable short positioning in the market.

Being short gold in 2013 was a phenomenal trade, as the metal fell nearly 30 percent. But at this point, gold bears may be overplaying their hand.

"There are a significant people out there who really believe the gold price should be much lower, and you have a record amount of shorts in the market" said Mihir Dange, a gold options trader with Grafite Capital. "But usually record shorts and a rally should lead to some sort of squeeze somewhere."

MacNeil Curry, head of global technical strategy of Bank of America Merrill Lynch, believes a squeeze could be coming extremely soon. Curry said that $1,270, a level gold is touching on Friday morning, is a critical level.

"Twelve seventy is significant, because if you go back and look, it has been a pretty sizable pivot from about just off the June lows," Curry told CNBC.com. "Every time we've broken above or below, you've seen decent follow-over, especially on a closing basis."

Once $1,270 is broken, then, "you're going to see people bailing. Technically inclined people, at least, will exit their shorts," Curry said.

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Curry is not the only one closely watching the level. In a note Thursday, RBC's widely followed precious metal strategist George Gero wrote that "a close over $1,275 would signal momentum traders to re-enter the long side."

And while Dange says he doesn't know exactly where shorts will get squeezed, the trader did say that $1,276 is a level he is watching closely.

Of course, all the interest in the $1,270 to $1,276 level is not a coincidence. On June 20, when gold lost $75 in a single session, the metal made a low of $1,275.40, and found support at $1,268.70 on the following day.

"You have to assume that there's a lot of people who shorted the market since that tumble, so that's probably where people sweat," Iuorio said.

And as people look to exit increasingly painful short bets, the market could move significantly higher. BofA's Curry said that once it crosses $1,270, gold will be eyeing resistance between $1,362 and $1,399.

—By CNBC's Alex Rosenberg. Follow him on Twitter @CNBCAlex.

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